Finding ways to improve defined-contribution pension schemes, where the risks are taken by the individuals instead of their employer, is the subject of increasing attention as DC schemes become the primary form of occupational retirement benefits.

Catherine Doyle: BNY Mellon

One current area of focus is the way in which schemes reduce their members’ investment risk as they approach retirement, and this was the subject of a panel session at last month’s Financial News annual pensions conference.

The basic idea of shifting members’ investments from equities to bonds and cash as they approach retirement is widely agreed to be sensible. However, attitudes are changing towards the way in which these shifts should be managed.

The most common way of doing it, called “lifestyling”, follows a pre-set path of reducing the equity allocation in the years before the member retires. A new way, referred to as “target date”, gives the pensions provider more discretion in timing the moves.

Speaking at a panel session, Catherine Doyle, a DC specialist at BNY Mellon, said: “The performance of some lifestyle funds in 2008 showed us the shortcomings of this mechanistic approach. Research we did with Cass Business School [published last October] showed that a more dynamic approach to asset allocation radically improved the outcome. There is an appetite for something more sophisticated.”

Emma Douglas, head of Mercer Workplace Savings, part of the pensions consulting firm, also said the entirely mechanistic nature of lifestyle funds was a flaw: “You’re going to switch out of equities and into bonds at the end of the month no matter what the market is doing. As an industry, I think we can do better than that, we can make lifestyle more intelligent. That’s where a target date fund comes in.”

This was not the universal view, however. Jerry Gandhi, chief operating officer of Now: Pensions, a provider of workplace pension schemes, said: “Lifestyle and target date are different words for the same product. A mechanistic approach is probably better, because judgment calls in the area [of dynamic asset allocation] have historically been very bad.”

Patrick Heath-Lay, director of finance and strategic delivery at B&CE, which provides pensions for employees in the construction industry, said his organisation has stuck with lifestyling. Employing asset managers to make asset allocation decisions is expensive, and Heath-Lay said: “The more sophisticated you make the instrument, you have a cost, particularly to members with very small funds who will move on in a very small amount of time and could quickly find their fund being eaten up by that charging approach.”

But Paul Bannister, chief executive of the BlueSky Pension Scheme, which provides pensions to electricians and others in the electricity industry, is a convert to target date funds. He said: “We have made the complete switch from lifestyle to target date because lifestyle ignores market conditions.

“There is a slightly higher cost. They cost 0.1% extra per annum for the members. But we married it up with our annual management charge and the two together were acceptable to the membership.

“[On the basis of] what we’ve seen so far, [the extra cost] will comfortably be gobbled up by the smoother returns we get from the target date funds. In the short period that we’ve had these funds it’s proved the right thing to do so far.”

But BNY Mellon’s Doyle says that administering target date funds could become a headache, and a UK pensions provider could end up having many vintages of target date funds – one maturing in 2020, another in 2021, and so on – with few assets in them.

Bannister said: “It’s going to reduce the amount of work we do. The manager does a lot of the work for you. The small increase in the charge reduces some of our workload, so it should allow us to make savings.”